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Banks that received federal bailout money approved riskier loans and shifted capital toward risky investments, according to University ofMichigan researcher Denis Sosyura, whose research paper on the topic will be published later this year in the Journal of Financial Economics.

In a study on risk-taking by banks that received funds from the Troubled Asset Relief Program, Sosyura, assistant professor of finance at the Ross School of Business, found that the default risk rose 21 percent after the bailout compared with banks that didn't get such funds.

One of the objectives of TARP was to stimulate lending, but Sosyura and colleague Ran Duchin of the University of Washington found that TARP banks didn't issue more loans than non-TARP banks.

The federal government established TARP in late 2008 — the largest federal investment program in American history — to increase financial stability and stimulate lending to U.S. consumers and businesses. The Capital Purchase Program, the first and largest TARP initiative, invested $205 billion in more than 700 banks in 2008-09.

The study found that TARP banks shifted their credit originations toward riskier mortgages, as measured by the borrower's loan-to-income ratio and the percentage fraction of subprime loans.

The approval rate for mortgage applications by the riskiest groups of borrowers increased by 5.4 percentage points in 2009-10.

The study showed that TARP banks also increased their investments in risky securities, such as mortgage-backed securities, and reduced their allocations to low-risk securities, such as Treasury bonds.

"An important question is why the potential increase in banks' risk tolerance manifested itself through a shift toward originating riskier loans rather than through originating more credit," Sosyura said in a news release Thursday.

"Indeed, one of the simplest ways for a bank to increase its risk would be to loosen credit standards across all loan types and issue a greater amount of credit," he said.

Banks also used TARP funds to improve their ratios of capital to assets. The average capital ratio for TARP banks improved from about 10.7 percent in the third quarter 2008 to 11.6 percent in the first quarter 2009 after receiving federal money.

While the banks appeared steadier on paper, they were increasing their likelihood of running aground again by making riskier loans.

"The reduction in leverage was more than offset by an increase in earnings volatility associated with riskier lending," said Sosyura.